>STATE BANK OF INDIA (AVENDUS)

New norms that require all banks to reach 70% specific provision cover by Sep10 could catalyze merger activity within Indian public sector banks. In particular, SBI stands to gain if the amalgamation of its associate banks were to revive and accelerate. At end of Mar09 the provision cover of the standalone bank was 38.5%, 10.8% below that in the consolidated bank. The new norms would erode net profit for FY10f and FY11f by up to 18%. The erosion for the consolidated bank would be capped at 13%. Two associate banks have been merged with the parent and this experience could help to quicken the process for the other five. While these mergers may not have material impact on the numbers used in valuing the stock they could potentially re‐rate the P/E. We value the stock using a combination of P/E, P/B and DCF method. We maintain ‘Hold’ rating on the stock with Dec10 target price of INR2,123.

Provisioning norm may erode standalone pre‐provision profit by 18% The additional specific provisions required to raise the cover to 70% are estimated at INR72.5bn. If equally distributed over FY10 and FY11 they would erode our current forecasts for pre‐provision profit by 18% and 15%, respectively. Due to higher loan loss provisions, we had downgrade EPS forecast for FY10f and FY11f by 12% and 22%, respectively in our report dated 18th Nov09 “Rising concern on NPL provisions’’.

Accelerated NPL provisioning could catalyze mergers

Higher provision cover in consolidated book would cut burden by c5%: At the end of Mar09, the provision cover of standalone SBI, including writeoffs, was c57%. That for the consolidated bank, assuming the amount of writeoffs stays unchanged was 61%. So, the additional provisions required to reach the mandated 70% level would be INR69bn. Consequently, the potential erosion in pre‐provision profit would be capped at 13% and 10% for FY10f and FY11f, respectively. The erosion would be even lower if we consider the additional write‐offs made by the associate banks.

Merger with associate banks would cut the provisioning burden: Over the past two years two of the smaller associate banks were merged into SBI. The natural corollary of extending the mergers to the other five associates is taking a pause due to opposition from the bank unions. Now, the mandated surge in NPL provisioning adds to the argument for rapid progress of mergers with these banks. We value SBI using the consolidated numbers. So, the actual merger is likely to have little material impact on the valuation of the stock. However, these mergers have potential to re‐rate the P/E in the near term.

We value the stock using a combination of P/E, P/B and DCF method. We maintain ‘Hold’ rating on the stock with Dec10 target price of INR2,123.

To read the full report: SBI